South Korea’s central bank kept the interest rate unchanged at 3.0%, pausing a series of rate cuts that began last October. This decision comes despite growing concerns about heightened political uncertainties caused by the martial law crisis and sluggish domestic demand. Analysts point to turbulence in the foreign exchange market, with the won-dollar exchange rate hovering above the 1,460 won mark, as a major factor supporting the rate freeze.
The BOK’s Monetary Policy Board decided to hold the benchmark seven-day repurchase rate steady at 3.0% during its first policy-setting meeting of the year on Jan. 16. The BOK had previously raised the interest rate from 0.5% to 3.5% between August 2021 and January 2023 and then kept it unchanged for a year and seven months. The central bank began monetary easing last year, lowering the rate to 3.25% in October and then to 3.0% in November.
“While inflation has shown signs of stabilizing and household debt growth has slowed, unexpected political risks have increased downside risks to growth and heightened exchange rate volatility,” the BOK said in a statement.
“Based on growing uncertainties in the economic outlook and foreign exchange market due to changes in the domestic political landscape and the economic policies of major countries, the board has decided it was appropriate to maintain the current rate while closely monitoring domestic and external developments.”
Ahead of the meeting, the market had been divided on whether the BOK would opt for a rate cut or rate freeze. Sixty out of 100 analysts polled by the Korea Financial Investment Association responded that they expected the central bank to keep rates steady, while 40% predicted that it would cut rates by 25 basis points to 2.75%.
The recent surge in the won-dollar exchange rate trumped concerns about an economic downturn. After briefly dipping to 1,450 won per dollar amid speculation that the upcoming Trump administration might limit proposed universal tariffs to select products, the exchange rate surged back to 1,470 won following stronger-than-expected U.S. jobs data on Jan. 10. These developments reinforced the perception that the U.S. economy is set to remain robust for a while, raising the possibility of the Federal Reserve slowing rate cuts.
If the new U.S. administration under President-elect Donald Trump implements its proposed tariff hikes and tax cuts, driving up import and consumer prices and fueling inflation in the process, it could prompt the Fed to slow its rate-cutting pace. In such a scenario, the BOK would need to maintain the current interest rate differential of 1.5 percentage points to prevent capital outflows, making it difficult to proceed with further rate cuts.
The BOK may consider resuming rate cuts as the factors supporting lower rates, such as sluggish growth, still persist. Political instability, caused by President Yoon Suk-yeol’s short-lived Dec. 3 martial law bid and his subsequent impeachment, continues to dampen already weak domestic demand. Even before the martial law fiasco took place, retail sales fell 2.1% year-on-year from January to November last year, marking the steepest decline for the same period since 2003 (-3.1%), according to Statistics Korea.
The slowdown in export growth, a key driver of the Korean economy, is another factor backing rate cut forecasts. Data from the Korea Development Institute (KDI) shows that daily exports in December increased 27.9% on average for information and communications technology (ICT) products but declined by 3.6% for other items due to faltering global demand.
The BOK has projected Korea’s economy to grow 1.9% annually this year and 1.8% next year, below Korea’s potential growth rate of 2.0%.
